Quarterly Outlook

Q4 2009

SPECIAL NOTE
Growth in H2, but at
great costs  p. 4

MACRO
The Japanization of Financial
Markets  p. 6

FX
Recession on hold - but for
how long?  p. 8

COMMODITIES
Going into Q4 on a high  p. 12

EQ
Equity valuation in Japan-like
scenario  p. 14
 –  Quarterly Outlook Q4 -2009  –

The Japanization of Financial Markets

There is growing evidence that record fiscal and monetary stimulus has mitigated an extremely negative outcome in the global
financial system and economy. Most indicators of economic activity are stabilizing, but at very depressed levels. Prices, however,
are continuing to drift lower – both with regards to Housing and the general price level, which is suffering from massive lay-offs,
uncertainty and deleveraging. We believe that consumer deleveraging will continue for years and that the demand will stay sub-
dued. Especially the monetary stimulus is likely to continue and that might foster a “Japanization” of financial markets. In other
words, we might see even higher P/E’s and lower yields on both corporate bonds and treasuries. Government budget deficits will
continue to result in sizeable issuance of treasuries, but it appears that increased savings and deflationary pressures will stand in
the way of higher rates… for now.

2 Quarterly Outlook q4 – 2009

•
 –  Quarterly Outlook Q4-2009  –

David Bakkegaard Karsbøl

Chief Economist
David Karsbøl is Chief Economist and Head of the Saxo Bank Strategy Team. He is responsible for
the overall macroeconomic views of Saxo Bank. He has a Master’s degree in Economics from the
University of Copenhagen, where he specialised in finance, statistics and monetary economics.
David Karsbøl concentrates on Business Cycle Analysis and subscribes to the reasoning of the
Austrian School of Economics (Menger, Schumpeter, von Mises, von Hayek etc.). He believes that
an understanding of debt cycle is integral to understanding the general business cycle. He started
in Saxo Bank in 2003 as a macro strategist and joined the Strategy Team two years later. He has
headed the Strategy Team since summer 2007.
David is one of the bank’s most visible strategists and his contrarian thinking has made him
a frequently quoted commentator on macroeconomic issues and he is a regular contributor to
CNBC Europe. David is available for comments on the macroeconomic situation and forecasts.

Christian Tegllund Blaabjerg

Chief Equity Strategist
Christian Tegllund Blaabjerg is responsible for the overall equity view of Saxo Bank. He has a Mas-
ters degree in Political Science from University of Aarhus and a degree in Finance from Aarhus
School of Business.
Christian works with equity market and single stock analysis using a top-down approach. He
identifies macro forces that could affect the investment environment before they become obvi-
ous, and then focuses on individual issues within sectors and single stocks to determine how they
will be affected, whether they can capitalize on them, and if the stocks are attractively priced.
Christian appears regularly on major financial networks including CNBC and Bloomberg and in
printed media. He is available for comments on equity markets and major companies.

John Hardy
Consulting FX Strategist
John Hardy graduated with honours from the University of Texas at Austin and is Consulting
FX Strategist for Saxo Bank. John has developed a broad following from his popular and often
quoted daily Forex Market Update column, received by Saxo Bank clients and partners, the press
and sales traders.
John is a regular guest and commentator on several television networks, including CNBC and
Bloomberg. He also writes regular ad-hoc commentary focusing on the major currencies, Central
Bank policies, macroeconomic trends and other developments. He is also one of the authors of
the Saxo Bank Yearly Outlooks and 10 Outrageous Predictions.

Mads Kofoed
Market Strategist
Mads Koefoed is a Market Strategist at Saxo Bank and has been part of the Strategy Team since
May 2009.
Mads’ primary focus is macroeconomics and equities, and he is responsible for the Bank’s
Cross Asset Research. In addition, Mads will focus on the development of the Strategy Team’s
econometric models.
Mads has a Master’s degree in Economics (cand.polit) from the University of Copenhagen,
where he specialised in finance and econometrics.
Prior to joining Saxo Bank, Mads spent two years with Danske Capital, where he worked in the
Danish Equities team.

Quarterly Outlook q4 – 2009

• 3

 S P E C I AL N O T E : growth i n H 2 , b u t a t gre a t co s t s

The American economy will return to positive GDP Expectations abound that inventory changes will
growth in the second half of the year, but the sustain- drive GDP growth in the second half of 2009, and we
ability of this growth is questionable and will be due reluctantly embrace this view – for Q4 at least. Some
in large part to government spending and inventory restocking of inventories will eventually take place as
restocking. The American consumers, meanwhile, are stockpiles are depleted, but we remain sceptical that
still on life-support as balance sheets are deleveraged. the effect will be as large as expected (business inven-
tories for July fell another 1% and were revised down
Americans have hit the brakes in terms of spending for June to 1.4%). The inventory-to-sales ratio is still
and are only willing to consume when the government elevated relative to the trend in the last decade and will
dangles a carrot in front of them. Apart from such come down even further in Q3 as businesses remain
taxpayer-funded consumption, income is used to pay wary of refilling their inventories until more signs of a
off debt – some 110 billion in consumer debt alone sustainable recovery are present.
from the peak – and a slowdown is nowhere in sight.

There is no point denying that the stimulus packages ISM New Orders
work – momentarily, at least. The auto rebate (cash for - ISM Inventories and Private Invstment
clunkers) will provide a welcome boost to Q3 private 40 10%

consumption (and Q4 inventories), but we worry that

30 5%
most of this is simply forward pulled demand and will
instead be missing in 2010. The housing market has 20 0%

stabilised of late and sales are once again increasing. 10 -5%

This will also boost private consumption in Q3 and 0 -10%

Q4 and help make the American consumers appear

-10 -15%
healthier than they actually are.   Private Investment (QoQ, RHS)   ISM New Orders - ISM Inventories (Index, RHS)
-20 -20%

1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Private Consumption, Consumer Credit,

and Unemployment Rate Q4 GDP growth will be aided by inventory changes as
auto dealers seek to replenish inventories from cash
10% 20%

for clunkers. Their inventories are running low and we

8% 16%

expect some restocking to occur in Q4. In addition the

6% 12%
gap between ISM new orders and ISM inventories and
4% 8%
orders for durable goods are rising rapidly and confirm
2% 4%
our expectation of pending inventory replenishments in
0% 0%
the fourth quarter.
-2% -4%

  Private Consumption (Nominal YoY, LHS)   Unemployment Rate (LHS)   Consumer Credit (YoY, RHS)
+4% -8%
US government spending has been rampant in Q2,
1991 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

but the government faces two obstacles that must be

addressed for it to provide the same amount of growth
Other problems besides debt exist, however. Unem- to the third and fourth quarters. First, national defence
ployment keeps rising and will – if past recessions are rose by a ridiculous amount in the second quarter after
anything to go by, continue to do so for many months. a first quarter decline. The growth in national defence
This will hinder both debt repayments and consump- spending must continue at the same pace (13.3%),
tion as demand is not pent up to the same degree otherwise it will reduce GDP growth. Second, part
as savings are going into balance sheet restructuring of the debt-financed stimulus introduced through
instead of actual savings. transfer payments is not being used for consumption

4 Quarterly Outlook q4 – 2009 •

 as intended. Instead, American consumers are restruc-
turing their balance sheets by paying off debt. This is
recognised as savings in the national accounts, but
should not be confused with private investment. Until
balance sheets are restructured, savings will not go into
securing long-term growth through investment but
rather to reduce debt.
State and local spending, which increased 3.6% an-
nualised, contributed nicely to second quarter GDP and
it is questionable whether they can keep this up. Tax
receipts are way down and many states have problems
balancing their budgets. To achieve this they need to
cut spending, increase taxes, or further draw down
their already practically depleted funds.
but the effect is smaller transfer payments ending up
as private savings. Private gross investment will contrib-
ute less negatively in the third quarter compared with
the second quarter, while actual inventory restocking is
expected in the fourth quarter. Inventories will, in other
words, take over somewhat from government spend-
ing as the main driver of growth come Q4. Net exports
have done what they can to support growth, but will
not contribute much going forward. The American
consumers will contribute somewhat to third quarter
growth, but it will mostly disappear again in the fourth
quarter due to debt repayments and unemployment.
Market consensus for US Q3 annualised GDP
growth is 2.7%. We expect 3.0%.

Alongside government spending, net exports were

the main positive contributor to second quarter GDP
(1.60%). We do not expect the rapid improvement
in net exports – which was caused by large declines
in exports, but even greater declines in imports – to
continue in the second half of the year. Trade flows are
on the rise again – albeit from very low levels – and im-
ports are actually rising faster than exports despite the
crumbling dollar. Oil has risen from low levels earlier
this year and will need to fall again for net exports to
contribute positively to GDP in Q4.

Net Export

0 30%

-10 20%

-20 10%

-30 0%

-40 -10%

-50 -20%

-60 -30%

  Net Export (Billion, LHS)   Export (YoY, RHS)   Imports (YoY, RHS)
-70 -40%

1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009

Fiscal stimulus on the grandest scale ever seen will

make sure that the largest economy in the world posts
positive growth rates in the second half of the year.
Government spending will remain high in Q3 and Q4,

Quarterly Outlook q4 – 2009 • 5


 M A C R O : T he J a p a n i z a tio n of F i n a n ci a l M a r k et s ?

Our Business Cycle Indicator is showing a beginning It more and more looks like we have entered a new
turnaround in economic activity. It has actually showed regime, in which everyone assumes that big compa-
a slight improvement in each of the last five months. nies – whether financial players, blue chip companies
But since the indicator itself is built to show whether or Eastern European countries – will be bailed-out, if
the economy is accelerating or decelerating, a reading need be. In such a scenario, default risk needs to be
as negative as the one from the last half year is still not “priced-out”, which means higher price/earning ratios
very comforting. and lower yield on everything. It is increasingly evident
that the scenario bears a close resemblance to post-
1990 Japan.

4 4
What happened in Japan was a deep reluctance to
3 3
make big companies fail (especially banks). A combi-
2 2
nation of bad debt, deflation, negative demographic
1 1
development, cultural preferences and Ricardian
0 0
Equivalence has pushed down yields on all Japanese
-1   Saxo Bank Global Business Cycle Model -1
assets. In retrospect, it looks like the only thing that has
  World GDP Growth Per Capita
-2 -2
gone higher in Japan is government debt levels and
-3 -3
perhaps the price earning on the Nikkei. Half the time
01/05/1986
01/02/1987
01/11/1987
01/08/1988
01/05/1989
01/02/1990
01/11/1990
01/08/1991
01/05/1992
01/02/1993
01/11/1993
01/08/1994
01/05/1995
01/02/1996
01/11/1996
01/08/1997
01/05/1998
01/02/1999
01/11/1999
01/08/2000
01/05/2001
01/02/2002
01/11/2002
01/08/2003
01/05/2004
01/02/2005
01/11/2005
01/08/2006
01/05/2007
01/02/2008
01/11/2008
01/08/2009

since 1990, the Nikkei has been trading at a P/E of

more than 73. This amounts to not one, but two lost
decades with miserable (but positive) growth, eternal
Although we are sceptical about the current market deleveraging and falling home prices.
rally in risky assets and believe that the voracious
growth that is currently priced-in will disappoint, it is We don’t think that things will get as bad in the
perhaps too easy to be pessimistic. So many things Western economies. Our flexibility is bigger (although
– and especially the huge debt burden in Western our savings aren’t) and our culture to a larger extent
economies – are negative. It is in times like these that embraces the necessary change. Furthermore, asset
we have to remind ourselves that growth is a natural prices probably didn’t get as much out of sync with
state in the economy. Humankind is able to restruc- reality as they did in Japan in 1990. But we do believe
ture society in multiple ways to encompass changes in that we are witnessing a small-scale Japanization of
economies, risk-willingness, natural resources etc. financial markets. The P/E on all global stock indices
have shifted markedly higher in the past half year and
the “search for yield” that characterized 2004-2007 is
again dominating the market.

6 Quarterly Outlook q4 – 2009

•
 The extremely lax monetary policies of Western central
banks are flooding the market. Implicit and explicit
bail-outs are taking impaired assets off the books
of the financial sector and give them freshly printed
money to park anew on the roulette wheel. The
new money is pushing down yields on government
treasuries and corporate bonds, which helps keeping
the recovery-party going. We especially look at credit
markets for guidance on how long this optimism can
continue.

So far credit markets are doing quite well. Our High

Yield asset management department is frustrated due
to the oversubscription of HY issuance these months.
Issuance is often oversubscribed by a factor of 5. Look-
ing at total issuance, we are seeing a real return of
appetite for risk.

  Quarterly Global High Yield Issuance, Billion USD (LHS)   BAA Corporate Bond Yield, % (RHS)
100 100
90 90
80 80
70 70
60 60
50 50
40 40
30 30
20 20
10 10
0 0
1999_Q1

1999_Q3

2000_Q1

2000_Q3

2001_Q1

2001_Q3

2002_Q1

2002_Q3

2003_Q1

2003_Q3

2004_Q1

2004_Q3

2005_Q1

2005_Q3

2006_Q1

2006_Q3

2007_Q1

2007_Q3

2008_Q1

2008_Q3

2009_Q1

2009_Q3

For Q4-2009, we expect more Japanization of markets:

lower volatility, lower VIX, lower yields on Treasuries
and corporate debt, lower spreads. We also expect
higher stock prices and target the 1121 in S&P500,
which is the 50% Fibonacci Retracement in the “big
picture”. However, we believe that should be the top
in this cycle and that the negative impact from the
debt burden (lack of demand) should start to manifest
itself by then.

Quarterly Outlook q4 – 2009 • 7

F X : rece s s io n o n ho l d - b u t for how l o n g ?
In our Q3 FX Outlook, we envisioned a macroeconomic
scenario in which markets dove back into risk aversion
mode as we felt hopes for a recovery would prove pre-
mature. Clearly this was not the case, as risk appetite
remained very robust instead - punishing the USD and
supporting especially the growth-sensitive commodity
currencies. The recovery story has moved far enough
along that the market is pricing in interest rate hikes
in Q4 for the most confident central banks. Looking
back, our main misjudgement was failing to appreciate
the amazing power of unprecedented stimulus that
not only managed to stop the meltdown, to actually
reverse the negative developments and create such
widespread hope. Of course, with the Japanization of
markets as our theme, our view is that this recovery
will prove a false dawn.
While clearly we underestimated governments’ and
central banks’ determination and ability to resuscitate
the economy in the near term, the actions of the public
sector have failed to provide a sustainable foundation
for a strong recovery, though they may provide enough
momentum to keep the economy on life-support into
the New Year. Still, in FX, we suspect that the very
persistent one-way trends in risk appetite evident in Q2
and Q3 will begin to yield to more varied and treacher-
ous action in Q4, as the market may begin to doubt
the recovery’s resilience.
We have tried to identify a few key themes that the
market is bound to focus on as we head into 2010.
Are we really in a recovery?
Maximum stimulus is in the rear view mirror and
austerity and exit strategies are increasingly on the
menu. The FX market as a whole may begin to shift
away from the rosier recovery projection that is already
priced in, even if we fail to move back into all out risk
8
aversion a la 2008 just yet. This could likely mean the
exhaustion of many of the trends that are currently in
place in FX, where so many trades are aligned along
the ubiquitous risk appetite axis. The likes of the strong
AUD and NZD are the most extended if the answer is
“No”, though we’re not sure that Q4 will provide any
definite answers, which may first arrive next year.
USD weakness - how much further to go?
A USD short seems to be a vote for the global recovery
and has become the “newer and better” carry trade.
The country’s pathetic yields and need for external
financing and increasing reluctance from China to
buy greenbacks is a toxic cocktail that could drive the
currency even weaker in the near term. There may be
enough momentum already in place for the weak USD
trade as we head into Q4 to see another modest leg
down for the greenback, but if volatility rises again in
the new quarter, the USD devaluation story may falter
ahead of the New Year. Already, market positioning in
this trade has become stretched. Perhaps the quarter
will see a new low since last summer and then the
beginning of a comeback attempt.
Will we see the central banks beginning to
roll out their exit strategies as currently
priced in?
The market has priced in tightening for most of the
major central banks, the more aggressive ones like the
RBA and Norges Bank starting in Q4, while the Fed is
not seen tightening until the spring of next year. Will
these predictions prove accurate or is exit strategy
talk premature? As the stimulus fades, all eyes will be
focused on whether a real recovery can gain altitude of
its own accord. The beginnings of a tightening regime
may lay the foundation for unwinding some of the
moves we have seen since March, though Q4 may be a
bit premature to call for a full reversal.
Quarterly Outlook q4 – 2009
•
The Eurozone - are any special risks for
the single currency?
The Eurozone is in the crosshairs as Q4 gets underway
with the Irish referendum on the Lisbon Treaty in early
October. Ireland is among the Eurozone’s many eco-
nomic weaklings, all of whom are suffering with high
unemployment, imploded asset markets, ugly current
account deficits and a too-strong currency. A recovery
is nowhere in sight as we head into Q4 for these weak-
lings and we still have to wonder to what degree many
large Eurozone banks have swept their problems under
the rug. Challenging the viability of the Eurozone
is premature here, but internal strife could certainly
become more evident in Q4 and give reflex buyers of
overvalued euros a pause.
Forecasts for Q4:
USD: The sell-off will not turn disorderly - EURUSD
maintaining above 1.50 for long is unlikely assuming
that the equity market bull doesn’t go into overdrive.
A very weak Christmas shopping season out of the US
is likely to remind the world that the US consumer is
out for the count. Seasonality is against the greenback
if we are to take recent history as a guide, so picking
entry points may be a challenge, but we could see a
bottom for the greenback in Q4.
EUR: The ECB has turned very dovish relatively to its
formerly brave rhetoric. It is unjust to watch as the
euro has appreciated against the likes of the renminbi
over the last six months - as the world’s imbalances will
not be aided by continued knee-jerk reserve diversifica-
tion and EURUSD buying. The EUR has already been
extraordinarily weak vs. the AUD and other riskier cur-
rencies, so it may not be a “high beta” weakling if the
going gets tougher for risk appetite at some point in
Q4, but it could weaken against GBP, JPY and the USD
if we see a shift in the market paradigm in Q4.
GBP: The tendency may be for the pound sterling to
strengthen relative to the higher beta currencies in the
G-10 if risk appetite begins to finally wane at some
point during Q4, but at the same time to weaken
versus the JPY and the USD. A pair like GBPAUD is
certainly at remarkable, near multi-decade low, and we
wonder if this kind of action within the G-10 is getting
overstretched.

Chart: The USD is the new carry trade as this chart shows: here the USD is shown
together with the VIX measure of equity market volatility, global emerging market
equities, and spreads on US treasuries versus Emerging Market bonds. (Note: all
lines are inverted except for MXEF, the pink line showing EM equities)

Quarterly Outlook q4 – 2009

• 9

JPY: The market will have a new government to try
and acquaint itself with. JPY seems likely to remain in
solid shape as long as interest rates remain very low
and it is unlikely that the BoJ indulges in JPY-weaken-
ing attempts like it has in the past, especially with the
change of political guard. However, even a modest
rally in rates combined with another extension up in
equities could mean bouts of weakness in Q4. Eventu-
ally we would expect the JPY to show signs of more
durable firming against the commodity currencies.
CHF: The Swiss franc has lost its correlation with risk
appetite, and may have received a boost from the
persistent rally/resilience in bonds and the stabilisation
of key CEE currencies (due to their heavy indebtedness
in CHF-denominated loans) over the last quarter. Does
that make it a surprisingly risky currency if the pendu-
lum swings the other way now? A CHF forecast is also
complicated by the cat and mouse game of determin-
ing when and where the SNB will intervene. GBPCHF
will be an interesting trade to watch to see if it can
turn the corner to the upside: while the market is
punishing the pound for its QE measures, we must also
remember that Switzerland is also doing its own form
of QE through direct currency intervention.
CAD: The BoC is talking down CAD as a threat to the
recovery. Regardless, CAD is mostly bound up with
risk appetite and the global recovery scenario. The
currency’s recent strength is not helping Canada and
the country is still very dependent on its neighbour
to the south for much of its economy, and with end
demand expected to be down for the count for years,
it is tough to see CAD outpacing the broader market
for the longer term. The current account is headed in
the wrong direction and the strong CAD will not help
that development. We also have the prospect of yet
another election as the shaky Harper government may
not survive the quarter. CAD could top out vs. the USD
down within a stone’s throw of parity, but then we
could see it weaker against the market.
10
NZD: AUD and NZD have become the poster children
for the resurgence in confidence that things are look-
ing up for the global economy. We would give NZD the
edge over AUD in Q4, but NZD has rallied too much
and the central bank will begin to fight the apprecia-
tion tooth and nail, as the stronger currency is the last
thing the country’s nascent recovery needs.
AUD: The Chinese recovery has been a key for Aus-
sie strength. If China’s withdrawal of credit stimulus
begins to bite in Q4, then it may become apparent
that an AUDUSD north of 0.8500 and GBPAUD below
2.000 is already pricing Australia for perfection. There
are a few signs in the Australian data that the speed
of the recovery is faltering a bit, perhaps as the already
announced stimulus measures are petering out. Q4
could be the beginning of a rockier road for the cur-
rency and the RBA’s actions will be critical with the
market’s expectation that it will be one of the major
central banks to hike.
NOK: The Norwegian krone traded sharply stronger
in the quarter as oil prices rose and the market took
note of the Norges Bank’s more hawkish posture. NOK
could continue to perform well vs. a shaky EUR and
relative to other due to its unmatched balance sheet
when the world is worrying about currency devaluation
and due to its commodity exposure if the risk run-up
barrels ahead more than expected in Q4. EURNOK may
be on a path to 8.00 by mid 2010.
SEK: has performed very well with the recovery in risk
appetite and the bailout of Eastern European coun-
tries - particularly Latvia. As long as the “everything
will be bailed out” mentality holds, the SEK is likely to
shine during Q4 and EURSEK could dip below 10.00
at times in the quarter. A blowout of EM risk spreads
and decline in equities would derail the SEK recovery.
Equity and risk bears should consider long USDSEK
positions on dips. The Riksbank has been one of the
more aggressively dovish Central Banks - interesting
that the market has largely ignored this in favour of
risk indicators.
Quarterly Outlook q4 – 2009
•
Review of Q3 Positions
Our Q3 currency trade portfolio ideas were sufficiently
mixed to avoid major damage to the portfolio’s price
performance over the quarter despite the basic macro
scenario not playing out as expected as we spent
considerable effort trying to find trades that are not
correlated with the omni-present risk appetite theme
which seemed to make almost every trade an “either/
or” proposition.
Performance (Jul. 1 - Sep. 15):
Short EURUSD: - 4.50% The USD was pummelled as
risk appetite failed. Always gluttons for punishment,
we ponder a USDCHF long for Q4.
Short GBPJPY: + 5.26% Persistently low interest rates
helped the JPY, while disappointment about the BoE’s
persistent QE battered the pound.
Short EURSEK: + 5.74% Falling MA and general risk
premia and a weak EUR were a great combination for
the Swedish krona.
Short AUDNOK: +0.88% NOK caught fire in Q3, but
so too did the Aussie - we’ll try this trade again in Q4.
FX Trade Ideas for Q4
The basic assumption for Q4 is that no new meltdown
occurs, but that the melt-up scenario starts to play
itself out in the coming quarter. The main challenge to
this portfolio would be a runaway bull market in equi-
ties in this memorable year’s final quarter.
Short NZDJPY: (Sep. 15 rate: 64.00) Here’s a risky,
high beta trade for those who really want to take the
risk bulls by the horns. This is an all out bet that equity
markets will top out in Q4 and that the NZD longs take
a longer look down the road at some point in Q4. It is
also a bet that the low interest rate environment could
Quarterly Outlook q4 – 2009
• 11

persist longer than the market seems to think it will. Be
careful, though, this currency pair’s correlation with the
S&P 500 in Q3 was 0.91.
Long USDCHF: (Sep. 15 rate: 1.0350) The Swiss
Franc has benefited from two developments over the
last quarter: continued low interest rates have been
relatively supportive of this former safe haven of a cur-
rency. As well, stabilisation in CEE currencies helped to
stem the risk of a default on CEE holders of CHF debt.
This latter factor may have been a big contributor to
the franc losing its normal correlation with risk appetite
over the last quarter. This position is an attempt to find
a trade among the low yielders and a way to look for a
USD consolidation at some point before year-end. The
pair might have a run at parity before a rebound sets
in, however.
Short EURGBP: (Sep. 15 rate: 0.8875) If a Euro-neg-
ative scenario is to play out, then the valuation of the
single currency vs. the pound looks very steep. If risk
premia begin to widen at some point, the market may
also be far less prejudicial in valuing the “QE-heavy”
central banks. As with our NZDJPY and USDCHF ideas,
though, there is a risk that this trade is a bit premature
at the very beginning of the quarter.
Short AUDNOK: (Sep. 15 rate: 5.08) - we still like this
idea from our Q3 outlook. It performed well at some
points, but the broad AUD strength nearly matched
the NOK in the end. This is still a trade that is all about
valuation - NOK is undervalued and AUD is overval-
ued. Other angles include the potential for the market
to get a bit nervous about the status of the Chinese
recovery now that the Chinese authorities are begin-
ning to clamp down on the credit stimulus unleashed
earlier this year.
C O M M O D I T I E S : G oi n g i n to Q 4 o n a high
As we move through the last quarter of 2009 com-
modity markets will increasingly be looking for proof
that the global economy has indeed turned the corner
and will continue to recover. The sector as a whole has
generally been driven by the return of risk willingness
shown in the strength of stock markets and the weak-
ness of the US dollar and, more importantly, the yen.
One year on from the Lehman collapse the market is
full of the liquidity it lacked a year ago. Investors have
continued to look for investment opportunities and the
resulting liquidity has helped drive some sectors of the
commodity market higher over the summer.
Crude oil (CL) has spent most of this time in a USD15
range with much reduced volatility compared with the
panicky days seen early in the year. Expectations of
a swift global recovery and fears about future supply
were the main drivers of the recovery seen so far this
year.
OPEC has been largely successful in changing the
sentiment, despite their lack of compliance with
agreed production targets. Recent comments express-
ing satisfaction with current levels has left the market
range-bound for now.
The global oversupply has begun to dwindle, albeit at
a slow pace, which leaves the system well supplied in
the months ahead. Beyond this there is a chance that
prices will continue to recover into the New Year, find-
ing a new range between USD75 and USD85.
12
Near-term, however, we fear that recovery has been all
but priced into current levels. The autumn is often the
launch pad for significant market themes and there is
a real risk that the chain could come off and lead to a
period of negative returns. As always, given the very
high correlations to the US dollar and yen we continue
to follow developments in currency markets closely.
Crude oil is stuck in a USD67 to USD75.50 range at
the time of writing. Continue to play the range, but
look out for the risk of a break that we find to be high-
est on the downside, near-term. A break below USD67
leaves the market exposed for a move towards USD60,
with the risk of overshooting towards the 200-day
moving average at USD55 where support will be firm.
We expect year-end crude to be trading in the USD60-
65 range.
Natural gas (NG) has been the focus of much debate
and frustration from market participants as it contin-
ued to sell off over the summer as supply outweighed
demand by a considerable margin. This resulted in spot
natural gas reaching a multi-year low of USD2.41 in
early September before the historically profitable trade
being long NG and short of CL into the winter began
to lend support.
With storage in the US filling up well ahead of the win-
ter, only a cold snap or a pickup in industrial demand
will keep it from trading weak in the weeks ahead.
Quarterly Outlook q4 – 2009
•
Gold suddenly came back to life in early September
after months of just tracking the ups and downs of the
dollar, reaching the psychological level of USD 1,000
for the third time in history.
We find the timing of the break above USD1,000 a bit
questionable compared with the two previous occur-
rences. The first time in March 2008, the dollar hit an
all-time low versus the euro and a multi-year low on
the dollar index. This was a time when the talk was
about the EURUSD reaching 2.0000. This euphoria
about a weaker dollar drove gold prices to its current
record at USD1032.70.
The second time, in February this year, was in the midst
of the financial crisis which drove investors into gold
as a safe haven. This particular move was also aided
by strong physical demand and strong inflows into ETF
(Exchange Traded Funds).
During this current rally we have seen and heard of
little or no physical demand and the dollar is weaker,
though not as weak as the first time round. Investment
flows into ETFs have been steady without any major
pick up. What has increased significantly is the specula-
tive open interest on COMEX which indicates that the
move is primarily driven by short term speculators who
have been looking for a big follow through on the
break above USD1000.
We managed to reach a high of USD 1,024.28 before
moving back to USD1,000. We recommend buying
dips above USD 970 and would look for the creation
of a new trading range towards USD 1,300 should
1,032.70 be breached.
However, if the all-time high is not broken, we target
950 end of year.
Grain markets have traded lower over the summer
as continued perfect growth conditions in the U.S. has
increased the likelihood of a record crop year for corn
and soybeans. During the next few weeks look out
for any forecast about frost, which could change the
scenario. Also news about severe drought in China’s
corn producing regions could lead to increased level of
imports, which again would support prices.
Much hedging and expectations are now priced into
these markets and we feel the upside risk is now
greater and would look for support in corn at USD300
and soybeans at USD880.

Quarterly Outlook q4 – 2009

• 13

E Q : E q u it y v a l u a tio n i n J a p a n - l i k e s ce n a rio
The rally across global equity markets has been over-
whelming. For our part we continue to be sceptical
over whether the rally was fundamentally justified
as we still anticipate a sluggish recovery in global
demand. Even so, valuations are no longer as support-
ive for markets as they were earlier this year, making
substantial gains more unlikely. First, a further multiple
expansion is likely to require more visibility about the
cycle, but it will in the short run most likely be driven
by the large amount of liquidity in the market and sec-
ond, substantial earnings upgrades are likely to require
a stronger growth trajectory than now appears likely.
As we are looking towards end of the year, market
dynamics indicates a shift from the main drivers of this
year’s performance. We anticipate a shift away from
macro trends towards micro trends. In particular we
expect that the outperformance of cyclical, high beta,
high risk and low quality has run its course and instead
heading towards a more balanced portfolio driven by
specific growth and valuation properties. We especially
advise underweighting financials due to relaxation of
accounting standards.
We believe investors should continue to take cyclical
risk through regional allocations. We remain positive
towards emerging markets, while we are more scepti-
cal towards Europe and the US.
What we have seen so far this year
During the latter part of 2008 and 2009, the sharp
rise in equity premiums and associated collapse in
market multiples suggest that global equity markets
were driven mostly by fear. In addition, worries about
growth prospects were acute, which led to a substan-
tial downgrades in earnings expectations. This led
sectors and stocks more exposed to cyclical risks to
underperform in many cases resulting in extreme valua-
tion imbalances.
As economic indicators began to stabilise and policy
initiatives took hold, equity markets rebounded as dis-
aster scenarios were averted. The global equity market
14
rallied 59% from the March lows through August. This
move has been accompanied by substantial increase in
risk appetite. Moreover cyclical sectors have substan-
tially outperformed (by more than 30% from March to
August) more defensive sectors. The consequence has
been that cyclical relative performance has rebounded
back to September 2008 levels. Furthermore the rela-
tive valuation case for cyclical has become much less
supportive and consequently we believe the period of
broad cyclical outperformance is largely done.
Where we are heading
– towards emerging markets
We believe a shift in performance trends is likely.
As valuations have moved closer towards estimated
fair value (the MSCI World is close to 14x forward
12-month earnings) and a number of economic head-
winds remain, we see the influence of recent market
drivers as likely to moderate. As we argue in “The
Japanization of Financial Markets”, multiples might go
even higher, since most of the default risk has been
avoided due to government interventions, but earnings
are not likely to improve significantly from here.
In our view a unifying driver (increased risk appetite)
will not drive markets as we have seen since March.
Rather, many different factors will drive markets, sug-
gesting that micro trends will become more important.
Hence, we believe sector-specific growth and valuation
stories will be increasingly important driving markets.
An important part in these stories will be the different
growth outlook for regions – where growth can be
maintained and improved.
As we are moving away from an outright defensive
allocation under the assumption that market continues
to price in a normal earnings recovery we suggesting
three themes will be the important drivers within sec-
tors – namely: 1) Domestic cyclical recovery, 2) Global
secular growth and 3) Dividend growth. Following
these themes we are exposing ourselves towards en-
ergy, materials and consumer staples. We reiterate that
we do not suggest entering long positions in financials,
Quarterly Outlook q4 – 2009
•
 despite the rally within this sector due to relaxation of
accounting standards. This relaxation has led to a situ-
ation where it is very difficult to perform a valuation of
banks because there are no standard after which their
assets is valued on their balance sheets.
Figure 2: Equity Index Targets based on DMM simula-
tions.
Figure 2: Equity Index Targets based on DMM simulations.

This cyclical risk exposure should however be moder- 18 Lows Estimated

ated within a regional setting. In that regard we prefer March 2009 lows in the
2009 (March) remains of
an overweight position in emerging markets and 2009 based
underweighting Europe and the US. on DDM
valuation
Earnings and index forecast DJ Stoxx600 171 158 212
On the back of our expectation for earnings develop-
S&P500 794 667 975
ment within the next year (12 month forwards) we
revise our earnings growth expectations marginally up- Nikkei225 7972 7055 9238
wards. We are especially concerned for the European
and the US earnings growth development.

Figure 1: Earnings Estimates 2008/2009 YoY

Europe US Japan
(Stoxx600) (S&P 500) (Nikkei225)
Old Expected
Earnings Growth -46% -40% -50%
(ex.financials)
New Expected
Earnings Growth -44% -39% -50%
(ex. Financials)

On the back of the recent rally in equity markets,

we are revising our lows estimate for 2009 higher
compared to the prior estimate. Despite the fact that
we believe that the current rally is driven mostly by
psychology and we observe a significant overshooting,
we do not expect the lows from March being taken
out within the rest of this year. As a consequence our
estimates for the lows during the remainder of 2009
are higher than the ones reached in March.

Quarterly Outlook q4 – 2009

• 15

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